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DaVita Inc. (NYSE:DVA)

Q3 2009 Earnings Call

November 03, 2009; 05:00 pm ET

Executives

Kent Thiry - Chief Executive Officer

Rich Whitney - Chief Financial Officer

LeAnne Zumwalt - Investor Relations

Analysts

Gary Lieberman - Wachovia

Kevin Ellich - RBC Capital Markets

Kevin Fischbeck - Banc of America/Merrill Lynch.

Darren Lehrich - Deutsche Bank

Justin Lake - UBS

Gary Taylor - Citigroup

Mark Arnold - Piper Jaffray & Co.

Operator

Good afternoon. My name is Maggie, and I’ll be your conference operator today. At this time I would like to welcome everyone to the DaVita third quarter 2009 investor conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)

Ms. LeAnne Zumwalt, you may begin your conference.

LeAnne Zumwalt

Thank you, Maggie and welcome everybody to our third quarter conference call. We appreciate your continued interest in DaVita. I’m LeAnne Zumwalt and with me today is Kent Thiry, our CEO and Rich Whitney, our CFO. I’ll start with the forward-looking statement disclosure.

During this call, we may make forward-looking statements; all of these statements are subject to known and unknown risks and uncertainties that could cause the actual results to differ materially from those described in the forward-looking statements. For further details concerning these risks and uncertainties, please refer to our SEC filings including our most recent 10-Q and 10-K.

Our forward-looking statements are based on information currently available to us, and we do not intend and undertake no duty to update these statements. Additionally, we’d like to remind you that during the call we will discuss some non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most comparable GAAP financial measures is included in our Form 8-K submitted to the SEC and available on our website.

I’ll now turn the call over to Kent Thiry.

Kent Thiry

Thank you, LeAnne. I’ll cover critical performance, bundling, healthcare reform and our outlook. First, clinical outcomes which we’ve first, because that is what needs to come first we are in the end, first and foremost a caregiver company, now at nearly 117,000 patients. First, adequacy, essential, how well we are doing at removing toxins from our patients’ blood this quarter 95% of our hemodialysis patients had a Kt/V greater than 1.2 its 90 day data.

Second with respect to vascular access, 64% of our patients had fistulas in place again 90 day data, certain even management for this in to managed 88% of our patients to hemoglobin levels between10 and 13 and last three months. For all these and other clinical measures, our patient outcomes compare very favorably to national averages, and the numbers would be even better and both an absolute and relative basis if we were to exclude acquisitions and de Nova in both those categories.

We do more than anyone else, and in both those categories it takes awhile to get those centers on average to the level that all the rest of our centers are at. Our quality outcomes not only result in healthier patients and families, but also create substantial savings for the American taxpayer and insured populations.

On to bundling proposed rule as you all know, as a lot of issues and mistakes and incomplete analyses and this is totally normal. The bad news is if they get their final rule wrong in any significant way, patients will be hurt badly and centers will close, potentially, a lot of centers, since we are a single DRG industry with lots of small centers and very high patient variability in terms of costs.

The good news is that this bundling program can also be a win/win for patients and the government if CMS is able to fix the stuff but they’re relentlessly working on. Big negative is that the proposed rule cuts the industry’s reimbursement by significantly more than the 2% that Congress intended that’s a big negative.

On the positive side it’s nice to look out there and see a market basket minus 1% in the future. It’s nice to look out there and see a billion dollars of spending that wasn’t previously bundled, now bundled, creating whole new avenues of competition and innovation.

Its nice over better situated than most others, the more integrated the service and product that are customers broadly to find as doctors, government, private payers, patient, the better off the LDOs are and finally, the challenges of bundling itself could lead to some very attractive acquisition opportunities. So, big negative and some positives lot of it hinging on the final rule. Just to wrap up the bundling commentary, a lot of work in a short timeframe so we have a lot of emphasis for the folks in CMS.

Congressional intent was clear, which was 2% savings for taxpayers, while having a bundle, which protects beneficiaries and encourages innovation, and it’s good that the kidney care community has a solid track record of working with CMS. On to healthcare reform the outcome of course is highly uncertain as we all know. For us, it gets pretty simple, although that’s always dangerous to say.

Any reduction in the number of private insurance patients is bad. Any increase in the number of private insurance patients is good. This is because 87% of our patients are government and we lose money on those 87% and rely on the cross subsidy from the 13. There’s a new category one has to consider now which is any increase in the number of publicly insured patients, but for whom the rates are negotiated in the market.

That may very well be a good, but hard to go any further than that, until it actually gets defined, that new third category relatively new on the reform scene. The other important point to note is that the more pressure there is on ESRD or Medicare spending in general, the more incentive will pass an peaks extension, which is manually going healthcare policy, but in the out patient are the only Americans who can’t keep private insurance even if it’s better for them and their family doesn’t happen to any other American unless you’re on dialysis.

Fourth and final topic for me, outlook. We’ve raised our operating income guidance for 2009 to the 930 to 950 range, reflecting our performance through the year-to-date. We also expect that we may modestly exceed our prior operating cash flow guidance of 550 million to 600 million, and we are initiating 2010 operating income guidance at a range of 950 million to 1.20 billion.

I’ll now turn over to CFO, Rich Whitney.

Rich Whitney

Thanks, Kent. Our third quarter was again characterized by healthy volume growth, stable private pricing, strong cost controls and very strong cash flows. Compared to Q3 of last year revenue was up 9%, operating income was up 10.5% and EPS was up 19% on a 1% lower share count. Non acquired growth was 5.2% in the quarter, which was an increase from recent quarters.

You should note that, however, when normalizing for the number of Monday, Wednesday, Friday days in the quarter, non-acquired growth would be 4.8%, still a solid number. Dialysis revenue for treatment increased $2.79 from Q2. The main contributors were increase in physician prescribed pharmaceuticals and increase in EPO ASP and an improvement in commercial rates.

These items were partially offset by some deterioration in private mix. Dialysis operating expense increased $3.28 per treatment sequentially. There were three drivers increased pharma utilization, increased pharma pricing, and a bunch of small puts and takes across a number of line items. Our quarter end cash balance was 582 million and over the last six weeks, we have purchased a total of 2.2 million shares for $121 million.

In summary, Q3 was a strong quarter across the board. Volume, revenue, costs, cash flows, as we look into Q4, there is risk that some operating costs could be higher and operating income could be lower as we often see a seasonal decline in labor productivity and an increase in G&A expense in the fourth quarter.

Additionally, as we move into 2010 there is risk that we could experience a more significant private mix decline due to sustained levels of high unemployment, as well as losses of private patients as a result of payer negotiations. Our expectations regarding these swing factors are reflected in our operating income guidance range for 2010. Okay, shifting gears, a little more on the proposed bundling rule.

We do not plan to discuss every detailed aspect of the rule in the prepared remarks of the Q-and-A I’m sure you can appreciate why, but there are four major areas of concern that we will cover. One, orals, two, labs, three, case mix and four, the transition adjustment. Okay, so the first issue, the inclusion of oral phosphate binders test par in the bundle.

Four points to make. The $14 per treatment proposed for the oral drugs is clearly inadequate to provide the appropriate level of care to patients. In fact, we estimate the cost is at least three times CMS’s calculation. Second point, CMS simply does not have the data to calculate these costs.

Third point, a pilot or a demo would really need to be done in order to help them capture the information and fourth point is that our legal analysis supports that they do have the authority to properly fund orals in the bundle, or to delay this provision if they choose to move forward on including orals in the bundle.

Okay, so the second issue, bundling of lab tests. CMS has underestimated the cost and added a 20% Co-Pay for labs. The kidney care community is recommended a discrete list of tests so that the costs can be determined accurately. Also, CMS should fully fund the labs and should not subject them to coinsurance, which would be consistent with the rest of the Medicare program as well as the intent of the Med legislation.

So these two issues combined amount to a shortfall of about $3 per treatment. The third issue, the expanded case mix adjustors. As you probably know, CMS has proposed to expand the case mix adjustors from three currently to 17. Many of these proposed adjustors are not the best predictors of high cost patients and in fact, have significant underlying issues in the real world.

For example, some of the adjustors are highly subjective. Others require data that is simply not available to us and for many of the administrative burden would be very high. Issue number 4 is the phase in adjustor. CMS has proposed a 3% phase in adjustment which would apply to both the bundled rate and to the transition rate and they’re doing this in order to account for a predicted optimization by providers of their individual decisions to transition or not.

This methodology, the one they use to estimate this phase in adjustment, is flood, and in fact it negates the original intent of having a transition period and would result in reimbursement cut greater than the intended 2%. So covered a lot of the things that are issues with the rule on a positive note, CMS did listen to the industry in a number of areas in the rule when putting forth the preliminary rule and they are engaging productively with the industry on many of the issues.

So we are hopeful that the industries analysis will inform them and assist them in making the appropriate adjustments in the final rule, but, in the end with no changes to the rule, centers will be forced to close. It is that black and white the good news is that we do expect there to be changes in the bundling rule, and of course, all of the uncertainties around exactly how much the rule will change between preliminary and final.

So, I will now turn the call back to Kent for a few closing remarks.

Kent Thiry

I am actually think, anything that I would say at this point would be redundant to what either Rich or I have said so let’s go straight to questions please, operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steven Silver. Please go ahead, sir.

Kent Thiry

Steven? Is your mute on, Steven? Operator, perhaps we go on to the next one and come back to him.

Operator

Absolutely, of course, next question comes from the line of Gary Lieberman.

Gary Lieberman - Wachovia

Thanks, good evening. Looks like you had some pretty good facility growths. Can you comment on Texas? You’d noted before that had been a bit of an issue was getting new facilities up and has that cleared up at all?

Kent Thiry

The short answer, it is cleared up, some and/or continuing to work at to the get it cleared up the rest of the way. We’re neither optimistic nor pessimistic the fact that we made progress is encouraging. The fact that there’s still a bunch sitting there is a little depressing and so we’re on it working and leading an industry coalition.

Gary Lieberman - Wachovia

Okay. Any more color? Is it just that they’ve actually hired some people to assign to the project, or what exactly has cleared it up to the extent that it’s been cleared up?

Kent Thiry

I don’t know the details anymore. I know the details from a few states, but I don’t know which details pertain to which states. In some cases it means, they’ve hired extra people. In some cases it means, that we’re paying for the surveys. In other cases, it just means that they got enough letters that they reprioritized themselves. So, it’s kind of a mixed bag of solutions depending on the situation. There’s no one silver bullet that’s going to solve it in every state.

Rich Whitney

Gary, on the issue overall, just to give you a sense, we’re pretty much in the same spot that we were last quarter in terms of the overall number that are delayed. However, I’ll say at this point, we’re do you down to somewhere around 15 that are in the category of having been waiting longer than six months, and the rest of them are more recently constructed centers.

So there has been some progress in getting some of these centers certified, but the extended time that it’s taking means that the states are just not keeping up with us in terms of the number of new centers we’re putting into the pipeline to be certified. So that’s generally, overall, obviously in target states like Texas it’s a bit more difficult.

Gary Lieberman - Wachovia

Great, that’s helpful. Then maybe can you talk a little bit about how the bundling of commercial contracts is going? Is that going according to whatever schedule you might have? Are there any issues in terms of transitioning from a rate perspective and any other issues associated with it?

Rich Whitney

Yes, we don’t have any particular schedule. I think as we’ve said in the past our percentage of bundled business has been increasing for the last several years, really, and it continues to increase this year, and we expect it to continue going forward. So we don’t have any particular schedule, and in some cases we’d prefer to be bundled. In some cases we don’t prefer to be bundled. It’s really situation dependent.

Gary Lieberman - Wachovia

Would going towards bundling be the cause of any of the issues you noted in terms of potentially losing contracts or anything of that nature?

Rich Whitney

No, just the typical rate discussions with big payers and trying to figure out a long term solution.

Gary Lieberman - Wachovia

Okay and then maybe finally, just in terms of uses of cash, I guess you’re up to about $580 million of cash on the balance sheet. It’s nice to see you guys repurchase shares and get a new authorization. I guess in terms of thinking of what the priority is for uses of cash could we potentially see an increase in the number of acquisitions, or where you guys think on that front?

Rich Whitney

Our priorities stay the same, that we always look first at strategically leveraged growth at an attractive return on capital. That’s always what we would like to do first and when there’s not enough of that in our near term future is when we turn to doing other things with the cash like buying back stock. It’s so difficult to predict when those attractive targets are going to be available. So we have our fishing lines out. We just can’t predict if we’re going catch anything soon.

Gary Lieberman - Wachovia

Okay, thanks a lot.

Rich Whitney

Thanks, Gary.

Operator

Thank you. Next question comes from the line of Kevin Ellich - RBC Capital Markets.

Kevin Ellich - RBC Capital Markets

Good afternoon. Thanks, guys. Rich, I wanted to go back to one of your comments from your prepared remarks about deterioration in the private mix. Could you talk about how much you guys are seeing? What is the payer mix now and how much do you expect in 2010?

Rich Whitney

What was the last part of your question?

Kevin Ellich - RBC Capital Markets

How much you’re expecting to see the mix shift in 2010?

Rich Whitney

Okay, got it. Okay, well, we have seen a trend of private mix deterioration in it, and it’s been in the neighborhood of 50 basis points over the past year or so kind of depended on exactly what time period you look at. You should note that our private patient count is still growing just more slowly than our government business, and that’s what weighs on the mix there’s really two primary drivers.

One is actually improving mortality. So, our patients on dialysis longer than 33 months, is growing faster than our patients that were on dialysis less than 33 months. This is, of course a good thing and is a reflection of our focus on high quality outcomes and a lot of the good work of our clinical teams, but it does, obviously mathematically, weigh on our mix.

Then the second driver is deterioration in our admissions mix, of the mix of our patients at admission and this is where we achieve the impact of unemployment and the decline in insured lives that are commonly reported by all the major insurers. The final point that I will make is that to date, the mix shift has occurred primarily in the lower rate segment of our commercial population and that’s minimized the impact on our overall rates. That’s answer your question?

Kevin Ellich - RBC Capital Markets

Yes, that’s helpful. Then going back to the bundling and the case mix adjustors, I think that was the third point that was brought up, I was wondering if there’s any case mix adjustors that Medicare did not include that you think should be included?

Kent Thiry

Yes, race. Race is actually as far more predictive power than any of the variables they played well, and it also has more pragmatic relevance in that there are dramatic differences in preponderance of different races across different centers. So, from a policy point of view, it’s both feasible, it’s humane, it’s implementalble and it’s mathematically relevant. So we hope they do that.

Kevin Ellich - RBC Capital Markets

Okay and then what about thoughts on alternative therapies like home hemo and not dialysis? I don’t think there’s some commentary about an add on payment for those therapies. What are your thoughts behind that?

Kent Thiry

We just have to wait for the final rule. There was no clear direction or statement or analysis in the proposed that would lead to us conclude anything significant yet. So, we just have to wait on that one.

Kevin Ellich - RBC Capital Markets

Okay, thanks, guys.

Kent Thiry

Thank you.

Operator

Next question comes from the line of Kevin Fischbeck – Banc of America/Merrill Lynch.

Kevin Fischbeck – Banc of America/Merrill Lynch.

Thank you. I guess you mentioned a couple times you thought that the rate cut from bundling would be significant more than the 2%. Have you guys come up with an estimate of how much you think that this proposal would actually cut rates?

Rich Whitney

Kevin, we haven’t and it’s in part because the case mix adjustors are virtually impossible for us at the moment to estimate the impact on us and there are so many different aspects of the rule that we sort of know it’s significantly more than 2%. There are a couple of big bucket that make up the vast majority of the difference.

You can kind of calculate what those are based on the information that we gave you, but trying to be any more precise than that, I think we would just get it wrong and we do believe a lot of it is going to change. So, we’re focused in on really those big four issues being the material matters that need to be delta.

Kevin Fischbeck – Banc of America/Merrill Lynch.

Okay and then I guess its sounds like you did most of the share repurchase in September and October. Is it that at all related to the proposed rule or I guess we could maybe talk about the decision to get back into share repurchase after not doing it in Q 2. Is that just a matter of cash balance being equity value and its too much or was there something about floor as but this proposal out there you felt more comfortable buying back stock?

Rich Whitney

Yes, I don’t know that we really want to parse that it finally. I think it really is what Kent said is that we prefer to spend our cash on growth opportunities and probably return on capital and when we can’t do that and don’t think we have more cash than we can invest in those kinds of activities in the near term, we choose usually to do some share repurchases.

I think the only other thing I would say earlier in the year, if you kind of wind the clock back, the economy and the financial markets were in a very different state of play than they were at the end of the summer here and healthcare reform I think was in a much carrier point of at that time as well. So I think some of those things moderated, I think that did influence our thinking as you look at our behaviors earlier in the year versus later.

Kevin Fischbeck – Banc of America/Merrill Lynch

Okay and then I guess, you mentioned that the guidance is up with the results in the quarter, but we love to kind of hear, I can see where you beat our numbers, but love to hear where you saw upside versus your internal estimate that helped you feel the need to raise guidance?

Rich Whitney

Well, I think first of all being three quarters through at the level that we’re at was sort of the primary reason to raise guidance. In terms of where we are outperforming versus our internal estimates, I would really reiterate what I said is sort of very good performance across the board. We were pleased with the performance on volume. Pleased with, in spite of some continued mix deterioration, pleased with the revenue trends, and the cost control has been really good, due to some great work by the teams.

Cash continues to be very strong with our LCM cash flow of greater than $700 million of the operating cash flow line. So, I’d say really across the board, I could get into a lot more detail, but I’m not sure that it would be particularly helpful.

Kevin Fischbeck – Banc of America/Merrill Lynch

To follow up on that mix shift point you made earlier about losing some of the lower paying commercial businesses, is there a reason for that? Is it just the way it worked out? Is there something you can point to, that that’s actually why we’re losing some of the lower paying and not losing the higher paying commercial?

Kent Thiry

Honestly, we don’t know. We have a few hypotheses that we haven’t been able to prove out, but we honestly don’t know, but it is factually true.

Kevin Fischbeck – Banc of America/Merrill Lynch

Okay and then, I guess last question, help Heparin, got to ask the Heparin question. I guess, mostly one of your competitors are talking about moving to an alternative drug option, I think what’s your thoughts there about Heparin or an alternative?

LeAnne Zumwalt

Yes, so, Citrasate could impact and help reduce the dependence on Heparin. We think that’s true, as to how much that is yet to be proven and will be entering a pilot with them on that and we’ll keep you posted.

Kevin Fischbeck – Banc of America/Merrill Lynch

Okay, great, thanks.

Operator

Thank you. Next question comes from the line of Sudeep Singh.

Darren Lehrich - Deutsche Bank

It’s actually Darren Lehrich calling from Deutsche Bank. How’s everybody doing?

Rich Whitney

Hey Darren.

Darren Lehrich - Deutsche Bank

So I just wanted to circle back on revenue for treatment. It’s been holding up very well in fact growing. I guess I just wanted to hear your comments about how your book of business and repricing into 2010 may have influenced your 2010 outlook, and maybe just the bottom line question is, are your 2010 rate creases from your managed care book consistent with what we’ve seen in recent periods?

Rich Whitney

Well, I would say that our experience in 2009 has been relatively consistent with prior years in terms of our ability to get reasonable rate increases. As to how that will play out for 2010 increases, we don’t yet know.

Darren Lehrich - Deutsche Bank

Okay. But you have a set of guidance out there, and maybe just comment on the visibility you have into the business that’s been repriced or the contracts that have been repriced thus far that will take you out into some point into 2010.

Rich Whitney

Yes. Okay, I’m not quite sure I’m getting the question, but certainly we have a percentage of our book that is longer term and where the pricing is known. We had another component of our business where we would have had activity in negotiating rates this year that would give us visibility into next year. Then we have what ends up being a majority of the business that is more short term, or we might not yet have visibility into our 2010 rates.

I’m not really sure that I’m answering your question. I think as we sit here in October, we had reasonable visibility into what our rates are for a lot of our book of business and going into the first half of 2010, but we also have lots of open conversation with payors as we always do about whether our rates should go up or go down or stay the same.

Darren Lehrich - Deutsche Bank

Okay, that’s fair.

Rich Whitney

I don’t feel like I’m answer your question, but I’m not sure that I understand it.

Darren Lehrich - Deutsche Bank

Let me switch gears just to G&A in the fourth quarter and the last several years, we have seen, as you mentioned, Rich, an increase sequentially on G&A. I guess my question there would just be, is there anything different about this year, such that G&A wouldn’t follow that pattern. I think you said in your prepared remarks that it’s typically been higher, but perhaps you’ve been able to do some things to alter that pattern and I’d just like to hear your thoughts on that?

Rich Whitney

Yes, it’s typically been hire of course, we’re doing our best to manage that, but we would predict that it would be somewhat higher in Q4 than in Q3. Nothing, particularly different about this year than prior years.

Darren Lehrich - Deutsche Bank

Okay and then Kent, maybe just an update from you, if we could, on the ancillary businesses. They continue to be a modest drag overall and I think are more or less inline with what you’ve guided to at the outset of this year. Can you just maybe provide with us some thoughts on where are we relative to getting to breakeven, what do you think needs to happen there and just timing around that.

Kent Thiry

The portfolio is very close to breakeven now and in 2010, we would not anticipate anything dramatically different, but why don’t you come at me again, Darren, so I can do a better job and that’s for you.

Darren Lehrich - Deutsche Bank

How is DaVita RX are doing, and I think you claim that you were going to be close to breakeven in DaVita RX by the end of this year. Can you just update us specifically on that and overall, I guess the portfolio of those businesses, when would you expect breakeven to be reached?

Kent Thiry

Okay, thank you. DaVita RX is profitable now and that makes us as just happy as you, and we hope it stays that way, of course, forever more. Lifeline, our vascular access business, remains profitable and it looks like it will nicely into 2010 and then the third of the big ancillary businesses, our integrated curt model that one the economics are tough to parsed a little bit, because there’s the business side which has revenue, including our two demonstration projects with Medicare, then there’s the part of it which is just R&D expense, which you really can’t count in the same way and we’d have to do some of that and want to do some of that anyway and village health will probably be slightly less unprofitable next year as this year. So, the one that was profitable remains and speculate the one map wasn’t now is and the last will stay on profitable through 2010.

Darren Lehrich - Deutsche Bank

Okay and I know I’m getting in the weeds, but CRO and infusion, are those two also profitable?

Kent Thiry

Infusion is also profitable, yes, nicely. So, what’s the other one?

Darren Lehrich - Deutsche Bank

That the CRO business.

Kent Thiry

Yes, that is also so some of five our profitable thank you for bringing up the other two.

Darren Lehrich - Deutsche Bank

Okay very good and I guess just a last question I have would just be around the buyback. I know people have asked this, but should we be think about your buyback activities around your free cash flow in any period, or should we consider leverage to be an option as you look at your buyback?

Kent Thiry

Rich will go that one in a second, but let me add one other fact is that is relevant for their portfolio question you are asking a moment ago. At separate from those five business lines, although, again, one of them, village Slaton, and Medicare models half business, half R&D also in the numbers that you see we have some IT expenses for our work on our electronic medical record and that’s exciting stuff, but it’s pure expense, and so that is another R&D number that shows up in that category, but now I’ll turn it over to Rich for your second question.

Rich Whitney

So, I think that leverage is certainly a possibility, as we’ve said in the past, we think the optimal leverage for this business is somewhere in the nature of 3.5 times of course that there are lots of external factors that could cause to you want to be higher or lower than that at any particular point in time, but generally overall long term we still believe that is a reasonable amount of leverage for the business and right now we’re somewhat below the low end of that range and generating a lot of cash, so it’s quite possible that could be a component of the plan overtime.

Darren Lehrich - Deutsche Bank

Very good, thanks a lot.

Rich Whitney

Thank you, Darren.

Operator

Next question comes from the line of Justin Lake - UBS.

Justin Lake - UBS

Thanks. First question, just kind of following up on your commercial payor mix discussion, given the deterioration that you’re talking about, I’m curious is there anything going on in the market that might leave you disadvantaged versus your peers, maybe geographic mix or commercial referral patterns?

Rich Whitney

Justin, not anything that we’ve seen or anything that we’re aware of we did note that the other major company didn’t reported a similar decline earlier today. We don’t have an explanation for you. We have not seen anything that would lead to us believe that it’s a competitive issue in nature.

Justin Lake - UBS

Okay. So if you’d look back over, let’s say, the last five to ten years is this a type of normal volatility you’re seeing here?

Rich Whitney

It would also just reemphasize that there’s really two components that are driving it. One is, the patients are staying with us longer, and that’s a significant contributor. The other is, then, of course, as I said the mix of the new admissions, but I want to make sure that you get that it’s both of those things.

Justin Lake - UBS

That’s helpful and then just on the deterioration, how much of that is built into 2010?

Rich Whitney

Certainly, we have some. We have sort of our best view built into 2010. I don’t think it would be productive to go into individual assumptions in the forecast, because it’s sort of the collection of lots of different assumptions, probability weightings and the like, as you know.

Justin Lake - UBS

Okay.

Rich Whitney

I think you asked whether there was, I didn’t answer your question about whether this is a normal mix trend.

Justin Lake - UBS

Right.

Rich Whitney

I think the answer to that is no, which is why we’ve brought it up the last couple quarters that we have seen over the last several quarters a bit of a change in trajectory there.

Justin Lake - UBS

Got it, but you do have something built in for 2010 you don’t want to share the exact?

Rich Whitney

Correct.

Justin Lake - UBS

Okay, and I guess just last question on 2010 guidance, can you walk us through some of the puts and takes I know you normally do this type of thing at Investor Day, where you talk about the two or three kind of things that could go right or could go wrong in that guidance grand. Can you walk us through some of that?

Rich Whitney

Yes, so the things that could push us to the bottom end of the range I suppose is the question you’re asking.

Justin Lake - UBS

Right.

Rich Whitney

Would be number one, this mix issue, this is not necessarily in order of importance, but this mix issue that we just discussed. Number two could be the outcomes of private pay negotiations. That always has to be on your list, just because of the nature of the economic structure of our business.

The third item that I would put on that short list would be our ability to maintain our cost performance, in particular in the area of labor. We’re benefiting at some level right now from a loser labor market than we’ve had in the last few years, and to the extent that tightens up, that will make it more difficult to maintain our cost trends in that area. Certainly, we’ll try as hard as we can, but that would be on my list as well.

Justin Lake - UBS

Got it, and if I could just take one whack at that commercial contract in question, and I’ll jump out, can you give us a line of sight on what percentage of your contracts have been negotiated for 2010? I know there’s always a potential for you, they’re evergreen and you could walk away, they could walk away, but if that doesn’t happen, is it 80% or is it 40%?

Rich Whitney

Yes, you know, I don’t have the number, Justin, and I don’t want to answer it a guess.

Justin Lake - UBS

Is I’ll take your best guess, Rich. Okay.

Rich Whitney

I guess probably since, the last point that you made about the fact that a number of them are evergreen and are not really longer term contracts, I don’t know that I’d be comfortable answering the question, because it could change at any moment, either because we decide to change it or because the payor decides to change it.

Justin Lake - UBS

Alright, thanks for the help.

Rich Whitney

Thanks, Justin.

Operator

Thank you. Next question comes from the line of Gary Taylor - Citigroup.

Gary Taylor - Citigroup

Hi, good evening. I missed the comments early in the call I think a question about commercial business being bundled was there any update that you provided or can provide just in terms of percentage of your commercial revenue that’s bundled today?

Kent Thiry

No, there was no particular update that we provided it’s not a number that we’d typically disclose in the past other than to say that a bunch of it is bundled and it’s been a percentage that’s been increasing overtime.

Gary Taylor - Citigroup

Okay a couple other questions. I guess there’s some sensing a fair amount of confidence that some of these significant issues in the bundling proposed rule are going to be fixed, so, I don’t want to misspeak, if that’s not the case, but can you maybe talk a little bit about how you’re involved in the process and kind of where the source of some of the confidence is that some of these significant issues are going to be rectified to a certain extent?

Kent Thiry

I think the way I’d clarify our thoughts and feelings is that we are confident they’re going to make some changes, because some of the mistakes are so clear and so big and so consequential.

Having said that, could still leave some bad stuff in there and so if you ask if we’re confident, they’re going to get it to be exactly what Congress wanted, which is 2% savings, with patients well protected, then we have to qualify our answer and say despite our confidence that they’re going give it a really good try, they will know if they’re going get there or not.

So that’s the distinction between what we’re very confident about, which is them correcting some of the big problems versus getting it exactly right consistent with the legislation, because that’s hard. As for the process of what we’re doing, in order to try to help them get it right, which is what most CMS folks want to do, I’ll let LeAnne answer that.

LeAnne Zumwalt

Yes, we have process with the community because the community is quite aliened here in terms of protecting patients and providers and so there’s two coal issue which you probably before which is the kidney care partners, broad coalition of manufacturers, patient groups, physicians, other folks in the community, and that process is working well and very well coordinated, where we bring our concerns together in an organized way and writing a group comment letter to CMS, with the appropriate backup in terms of analytics and legal support and then there’s the kidney care council, which is the coalition of providers, again very well coordinated. Again, very good resources does that answer your question?

Gary Taylor - Citigroup

Yes and just maybe a couple of follow ups, LeAnne, because I think you’re doing a lot of work on this. One when do you expect the final rule, I guess presumably by law they have to issue 90 days before implementation, which could be as late as October of next year, but I think we’re all hoping, given the amount of changes that we see the final rule well before then. So, when do we see the final rule and what are your thoughts on this slipping past January 1,’11 implementation?

LeAnne Zumwalt

Before inform us today I should clarify that gave give us in extra 30 days for the commentary not sure everyone on the fund not that for a comments now are due on December 16 versus November 16, which is good in terms of the data that we have might surprise.

Probably what that does is back up a little where we’ll see the final rule and I don’t have a date certain to which they would do that, but probably spring, late spring, would be my best estimate, although I’m not good at predicting these things, and as you know, the CMS process can change. As to delay beyond January 1 of 2011, we don’t have any indication that they would be trending in that way. I don’t know if you have any other data, but we have no evidence that they would be thinking in that direction.

Gary Taylor - Citigroup

Okay, thank you.

Operator

Next question comes from the line of Mark Arnold - Piper Jaffray & Co.

Mark Arnold - Piper Jaffray & Co.

Good afternoon. Great quarter, guys. Maybe just start with and I think I missed this in the prepared remarks, so part of me asking it, but the revenue pretreatment growth drive, you just talk about that and we’ve seen a couple quarters in a row here of very strong revenue pretreatment growth. Can you give us any sense as to where this is headed in the next few quarters? Are some of those drivers going to continue, in your estimation here in the coming quarters?

Kent Thiry

Okay, Mark, the drivers sequentially in the quarter were an increase in physician prescribed pharmaceuticals, an increase in the EPO ASP and an improvement in our commercial rates and then those items were offset by some deterioration in the private mix, so those were the words that we used to capture the reality.

I would say then that as it relates to pharmaceuticals, we have seen pharmaceuticals increase over the last couple of quarters, although I would say it’s pretty stable at this point, if you look at Q3 and kind of compare to where we ended Q2, doesn’t seem to be a lot going on at the moment.

Going forward, sort of hard to ask to us predict what our rate trends will be, because it will be two things. It will be our rate trends, and it will be our pharmaceutical intense tees. On the rate trends, all we can tell you what we then experiencing which is normal reasonable increases which is very important for us given the Medicare loss that need to fertilized. On the intensities, as I said stable right now, after handicap. I guess we would say, if anything, maybe a little downward risk.

Mark Arnold - Piper Jaffray & Co.

That was helpful. Just a couple others here, home infusion, I think Darren asked a question about the profitability, but Kent is there any update you can give us on this business just in general, and are you at a point where will you look to maybe grow this business through acquisitions?

Kent Thiry

We would like to grow it, a little bit of history. We bought it, and then the first year promptly some other it with big company attention a pretty embarrassing performance on our part and so year two was one of recovery and we give a lot of credit to the leaders of that group and some of the leaders within the bigger ship DaVita who stepped in and did that and now we’ve got nice economics, nice clinical out comes we’re building the organization.

We’re driving some growth, and so we’re not prepared to say anything bold, because there’s too good a chance we would fail to satisfy anyone downstream, but we are hoping we can ramp up the growth and whether time will turn that into material growth, given the size of the rest of the enterprise, that’s for us to try to figure out if we can deliver or not with adequate return on capital. So, we’re wide open to it and we’ll see what happens.

Mark Arnold - Piper Jaffray & Co.

Okay. One last question and I guess since probably for Rich again. Can you just reconcile the share repurchases and the share count in the quarter and then kind of to the cash flow statement the difference between the 62 million in shares that you repurchased versus what the cash flow statement is kind of showing on the purchase of treasury stock plan?

Rich Whitney

I think the answer to your question is the delay in settlement of the repurchases made in the last days of the quarter. That would be why there would be a difference between what shows up on the cash flow statement and the reported purchases.

Mark Arnold - Piper Jaffray & Co.

Great, thank you, guys.

Kent Thiry

Thank you.

Operator

I’m showing no further questions at this time, sir.

Kent Thiry

Okay. Well, thank you all very much for your interest in our company, and we will do our best to do well for you in the months and quarters to come. Thank you.

Operator

Thank you all for joining today’s conference call. You may now disconnect.

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Source: DaVita Inc. Q3 2009 Earnings Call Transcript
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